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Weekly Market Report - April 2, 2024

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 Owners will do everything they can to avoid cutting rents—a critical metric used to determine property values


Office rents in the US are rising due to soaring vacancy rates, a record amount of available sublease space, and rising defaults. However, average US asking office rents are $35.24 a square foot, compared to $34.92 in the fourth quarter of 2019. This is due to the commercial real-estate market's unusual approach, where rents are a critical metric used by lenders to determine property value. Landlords are trying to justify the elevated levels by offering incentives like expensive interior build-outs and months of free occupancy.


Office vacancy is at record levels and continuing to rise due to flexible workplace strategies adopted during the pandemic. Businesses occupy 200 million square feet less than they did before the recession of 2020, and another 150 million square feet of negative absorption is expected to be added over the next two years. The office delinquency rate on mortgages converted into securities has soared to 6.63%, more than triple the 1.87% rate in January 2020. Some restructuring talks may lead to sales or foreclosures, resetting property values to reflect market conditions.



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Only 3.5% of offices sold last year came from a distressed seller, thanks to optimism and forgiving lenders


Office-building owners in the US are facing pressure due to the Covid-19 pandemic, with the vacancy rate rising from 11% in late 2019 to 17% today. However, forced sales are still rare, with only 3.5% of all office deals in 2023 involving a distressed seller. The strong economy is helping delay the day of reckoning, as most tenants are still paying rent. Lenders are eager to kick the can down the road, as they don't want to force borrowers to sell buildings into a weak commercial real-estate market. Office loans are more complex today than during the 2008 crisis, making it difficult to agree to foreclose or sell a property. Opportunistic investors are crawling out of the woodwork with offers of debt, but the office sector's need for finance will soon massively outstrip supply. CBRE thinks U.S. office landlords face a $72.7 billion refinancing shortfall between now and the end of 2025. The lack of distressed sales might be a sign of wishful thinking, as some borrowers and their lenders are likely holding out for lower interest rates and hopes for some office demand.


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The average US office rent is higher than in Q4 2019, despite surging vacancy rates, a glut of sublease space, and a wave of defaults. The mean office rent is $35.25 per square foot, slightly higher than in Q4 2019. Office owners are reluctant to cut rents, even keeping spaces intentionally vacant to avoid reducing the property's appraised value. This could lead to covenant default on loans or make refinancing harder. Experts predict that the rent bubble will burst once owners and lenders sell distressed office assets or restructure mortgages. To justify high prices, owners are investing in top-notch tenant improvements and offering lengthy periods of free rent. Certain amenities, such as roof or sky terraces, courtyards with outdoor seating, and LEED certification, have a significant impact on rent prices.


The rising average office rents coincide with a massive amount of negative net absorption in the US, with experts projecting an additional 150 million SF in the next two years. This trend, coupled with an increasing number of distressed properties, is starting to soften the office market and drive down rents for tenants in metros like San Francisco.



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Lawsuit: Relying on pre-Covid rent is a “grievous” miscalculation


Manhattan retail condo owners, including Kim Kardashian's company, are suing the city's Department of Finance for overly high tax assessments. The properties have lost millions in rental income since Covid, and are now "grievously overassessed," according to a lawsuit filed in state court. The assessed values are based on income and expense information from 2022. Anchor tenants at all three buildings have either ended or renegotiated leases since 2022. The owners argue that based on two-year-old gross income is unlawful and results in a tax liability that is severely disjointed from the property's condition and use as of the taxable status date. The owners are now requesting that the city recalculate the assessed values of their properties. The finance department denied the request, and the owners are arguing that using market rents instead of pre-Covid rents is the only way to avoid foreclosure.



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Tech company has a 33.8% office vacancy rate


Amazon is aiming to reduce its office vacancy rate by approximately $1.3 billion by not renewing leases, terminating others early, and ending the use of some floors. The company's office vacancy rate is 33.8 percent, which is expected to drop to 25% this year and to 10% in the next three to five years. The company has also been pushing to relocate employees to central hubs, reducing space at non-essential locations. Amazon mandates employees to be in the office at least three days a week and has pressured remote employees to move closer to central offices.


An internal petition against Amazon's return-to-office policy was signed by over 30,000 employees, but was rejected by the company. In November, Amazon was seeking 50,000 square feet of office space in Miami-Dade County.



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New York's in-office occupancy rate has reached a leveling point, with offices consistently about 50% full as they were before the pandemic. The city's in-office occupancy rate was 51.1% for the seven-day period ending March 13, down just 0.2% from the previous week and within two percentage points of where it has been since mid-February. The city reached its post-pandemic peak on February 7, when office activity totaled 52.1% of what it was pre-pandemic. However, New York's return to the office rate continues to trail some major U.S. regions, such as Chicago, Austin, Dallas, and Houston. However, New York's in-office recovery is slightly higher than that of Los Angeles, Philadelphia, San Francisco, San Jose, and Washington D.C. Hybrid work has made it more diverse, with Tuesday being the busiest day with New York clocking in at 63.6%. The Real Estate Board of New York released a report earlier this month looking back at in-office visitation data for January, showing New Yorkers were in the office at a rate of 63% compared to pre-pandemic levels.



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A prewar office building near Union Square, built in 1903, has been sent to special servicing due to falling property taxes. The building, which is 140,000 square feet, is facing rising vacancy rates and declining cash flow. The former anchor tenant, Compass, is subleasing space, and half of the 11-story building is available immediately. The building's mortgage is due in 2027, but special servicing is where loans showing signs of trouble are worked out. The property tax bill for 90 Fifth shows new charges of $1.8 million due by Jan. 2, 2024, plus outstanding charges of $2 million.



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A gallery space in Chelsea, New York, is facing foreclosure after the landlord reduced rents during the Covid pandemic to prevent art dealers from leaving. The ground-level retail space, owned by real estate investor Savanna, has a 16,000 square feet gallery space that is 100% occupied. Tenants include Miles McEnery, who showcases contemporary painting, and Yancey Richardson, who specializes in 20th century and contemporary photography. The landlord's $14 million mortgage for the posh storefronts was transferred to special servicing, and the special servicer is dual-tracking foreclosure while negotiating resolution options. The U.S. art market experienced a 10% drop in 2023 sales, with 48% of dealers expecting sales to remain the same this year and 16% expecting a decline.



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Billionaire real estate executive Charles Cohen will have to pay $544 million to Fortress Investment Group if the investment firm wins a lawsuit filed against him. Cohen Bros., Cohen's real estate firm, agreed to lend up to $534 million to multiple limited liability companies linked to Cohen Bros. in September 2022. Cohen personally guaranteed the loan, and the LLCs failed to make $25 million worth of loan payments in February. Fortress demanded immediate payment of the loans' outstanding principal and interest, totaling around $544 million.


Cohen Bros. Executive Vice President David Fogel said they are hopeful for a mutually satisfactory conclusion. Cohen Bros.'s Manhattan properties have been particularly affected by the pandemic, with occupancy rates dropping and vacancies increasing.



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GDS Development Management and Sabal Investment Holdings have acquired a controlling stake in Manhattan's Metropolitan Tower for $82.6 million. The deal follows a joint venture with German lender Aareal Group to acquire the distressed debt tied to the Plaza District tower. The 77-story tower, which includes an 18-story office condominium, was acquired in 2006 by L&L Holding and Mitsubishi. The owners refinanced their debt tied to the office condo with a $92.5 million loan from Aareal Group in 2021. The building, which has been the headquarters of L&L, is currently about 60% leased.



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Clune Construction has signed a lease at 655 Third Avenue, a high-rise in Manhattan's Murray Hill submarket. The move will relocate the company's headquarters to the 10th floor, boosting its occupancy rate from 52% in 2022 to 85%. The building, which has undergone a green transformation, has LEED Gold certification and is located near various bus stops. The property is also home to Abacus Group, Big East Conference, and Shinkin Central Bank. The Durst Organization recently negotiated a significant office deal with Paramount Group, which welcomed Citizens Bank as its latest tenant.

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